Only a decade ago, cryptocurrencies, also known as “cryptos,” were virtually unknown. Since the invention of the first crypto (Bitcoin) in 2008, thousands more cryptos have been developed. But Bitcoin, the original crypto, remains by far the most popular in today’s market and sets price records daily.
On December 20, Bitcoin (BTC) hit an all-time high of $24,228.83 per BTC – and has more than tripled in value in 2020. We hear regular pronouncements that insurance companies, hedge funds, and other institutional investors are piling into Bitcoin. Guggenheim Partners LLC, Paul Tudor Jones and Stan Druckenmiller have all jumped on the Bitcoin bandwagon. Indeed, Guggenheim analyst Scott Minerd has suggested that Bitcoin’s real value could be as high as $400,000 per BTC. Insurance giant Massachusetts Mutual just announced a $100 million Bitcoin investment. Even PayPal is getting into the crypto space – although for the moment, there’s not much you can do with your crypto on this platform.
And last week, Coinbase, the largest US-based crypto exchange, notified the Securities and Exchange Commission that it plans an initial public offering for its shares early next year. It will be the first major crypto-focused company to publicly offer shares.
Indeed, some financial analysts claim that cryptos (especially Bitcoin) have matured into a separate asset class from stocks, bonds, and other traditional investments. At the same time, conventional stores of value such as gold haven’t kept up. Indeed, Bloomberg Quint published an article December 1 entitled, “Bitcoin’s Rally Spurs Wall Street to Question Future of Gold.” Bloomberg points out that many investors are cashing in their gold exchange-traded funds holdings for Bitcoin.
So should you sell gold and buy Bitcoin? And has Bitcoin suddenly surpassed traditional stores of value, such as gold?
We try to take nuanced view on these matters. Bitcoin, and by extension other major cryptos such as Ethereum, are rapidly becoming mainstream investments. Yet, Bitcoin’s market capitalization is only 3% as large as gold.
As well, there were external factors affecting gold’s performance in November. One reason traders sold gold during the month was due to the presidential election proceeding smoothly (even with Trump’s refusal to concede) and progress toward a vaccine for COVID-19. Also, in the third quarter of 2020, central banks became net sellers of gold for the first time in a decade.
Further, we’re generally reluctant to buy any asset when it’s trading at an all-time high. And as the chart below indicates, Bitcoin prices have historically been extremely volatile.
The main argument for buying Bitcoin is that its supply is limited. Because of the way that Bitcoin is designed, it is mathematically impossible for more than 21 million BTC to ever be created.
However, Bitcoin is only one of thousands of cryptos. The supply is unlimited because anyone with the requisite mathematical knowledge can create their own crypto. Other than being smart, there are no substantial barriers to entry.
Bitcoin and similar cryptos with a “distributed ledger” do have one crucial privacy advantage: transactions occur peer-to-peer, without a middleman. There is no Bitcoin central authority. A Bitcoin transaction between you and your colleague in say, Madagascar, involves only the two of you. All you need is some Bitcoin, a computer or smartphone, and an Internet connection.
It’s hardly a surprise that law enforcement authorities, central banks, and governments find this decentralized trading system threatening. God forbid you be permitted to exchange value with someone else without Big Brother looking over your shoulder!
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Thus, in 2019, the Financial Action Task Force on Money Laundering (FATF) urged a global crackdown on cryptos, which it calls “virtual currencies.” The FATF has developed “best practices” that will require countries to register virtual currency exchanges and custodians. These companies will be obligated to enforce the same detailed “know your customer” rules that traditional financial institutions such as banks are obliged to do.
Another far-reaching requirement is a so-called “travel rule” for every transfer of value in virtual currencies. Exchanges and custodians will be obligated to determine the beneficial owner of the both the sender and recipient in any such transfer. They’ll also need to pass this information along to each other when transferring funds. If that’s too much trouble, and a country doesn’t want to deal with cryptocurrencies at all, the FATF guidance suggests they could be banned altogether.
As well, central banks and governments have indicated increased interest in cryptos linked to a fiat currency or a basket of fiat currencies – so-called “stablecoins.” The Federal Reserve, the European Central Bank, the Bank of England, and other central banks are exploring how stablecoins might fit into the currencies they oversee. And last April, the Chinese Central Bank formally launched a digital renminbi.
But the biggest advantage of stablecoins from the standpoint of central banks and governments is that cryptos tied to a fiat currency can be micro-managed. Central banks will directly control the stablecoin supply, making it possible to inject fiat money into the economy with the click of a mouse. And central bank cryptos can function literally as programmable money under whatever provisions the bank wishes to employ. This would allow Big Brother to decide how you’ll be allowed to spend your money and encourage or prohibit certain purchases or behavior.
With these developments in mind, we think it’s a bit early to classify Bitcoin as its own asset class. Buy if you choose, but don’t be surprised if a combination of competition, stifling compliance rules, and government-backed stablecoins erode its popularity.
